How Your Ex-Spouse Could Inherit Most of Your Money

May 23, 2014 -- If you have a will — and you should have one — you may have executed it after years of putting it off. You’ve paid your attorney a lot of money and given serious consideration to make the right choices and ensure that the will is air-tight. Finally your will is finished, and you can sleep soundly knowing that your heirs will receive the assets that you intend. Right?

Not necessarily. Most people aren’t aware that their wills don’t have the final say concerning assets held in retirement accounts — 401(k) plans and individual retirement accounts (IRAs). The beneficiary provisions of these accounts supersede those of wills. So clear is the law on this point that some financial people call retirement-account beneficiary designations “substitute wills.”

For those who are divorced, this problem could result in a posthumous nightmare: Your ex-spouse might get your IRA assets. The lack of awareness of how inheritance of retirement account assets works is a pervasive problem in a nation where 401(k) accounts contain nearly $6 trillion in assets and IRAs, about $6.5 trillion. Indeed, most of Americans’ liquid assets are held in such accounts. These assets, plus their homes, make up the overwhelming majority of most people’s estates.

Rules governing 401(k) plans require that account assets automatically go to the person who is your spouse when you die – unless you get your spouse to relinquish his or her claim to the assets and file the required paperwork with your employer demonstrating this and designating your intended beneficiaries. (A copy of a prenuptial agreement won’t dot; you must file the spouse’s sign-off that they are giving up any claim to the assets.)

After your death, your IRA assets go to whomever you designate as the beneficiary when you set up the account, unless you’ve since filed an updated beneficiary form. If your life situation has changed in the years since you set up the account, there may be a conflict with your will, especially if the will was drawn up more recently. You may now be divorced and remarried. You may have had no children when you set up the account and now have grown children who you want designate as beneficiaries.

Failing to attend to these issues could result in unintended outcomes. Regarding your 401(k) assets, your children might be left out. Recently I learned about a family where the father was wealthy and had most of his assets in his 401(k) account. He intended for his three grown children from his first marriage to be his only heirs. Although his new bride of two months recognized this preference, upon his death the full 401(k) account went to her. Because the father hadn’t arranged for his new wife to relinquish her claim to these assets and hadn’t designated his children as beneficiaries of the account, the children had no clear claim to the assets.

To assure that the right people inherit your retirement-account assets, take these steps: